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Mirror, mirror on the wall, will interest rates rise or fall?

No witch, no knight, no woods in sight; this tale of monetary policy is far more sinister.

Okay, maybe I’m getting a bit carried away. What I do know is that the direction of the next interest rate movement leaves investors and mortgage holders, many of you reading this now, feeling more than a little bit anxious, particularly with recent changes to investor lending policy (more of that at the end of the article).

Where are rates headed? A look at the yield on a cash rate futures contract is a good place to start:

  • ASX’s 30 Day Interbank Cash Rate Futures contract (fixes an interest rate on a certain sum of money for some point in the future), based on the Interbank Overnight Cash Rate published by the Reserve Bank of Australia, allows users (banks) to hedge against fluctuations in the overnight cash rate and better manage their daily cash exposures. Monthly contracts are available up to eighteen months in advance, and essentially provide an expectation of the direction of the cash rate. You can see in the figure below that the yield (interest rate) on cash rate futures contracts is declining to June 2016, indicating that the market (money traders at a bank) anticipates a high probability of a reduction of rates within the next financial year. Beyond that point, the forecast for rates is upward trending (albeit, long term projections tend to be less accurate).

A bank’s lending policy is, however, dually governed by the Reserves monetary policy (the cash rate) and APRA’s prudential requirements. We saw the impact of the latter this week when the ANZ and Commonwealth banks announced that interest rates on home loans held by property investors would rise by 0.27 per cent. The changes come after APRA forced banks to slow their loan growth among housing investors to 10 per cent a year, policy largely driven by the hype around the Sydney property market as well as the requirement of more capital against a banks’ loan book.

So what’s the moral of the story? Ask that mirror on the wall what the key to long term investment success is and the likely answer would be stress testing. Anyone who’s been to a meeting with one of Blue Wealth’s investment property specialists will know that the ability to hold an asset in an environment of increasing rates is a scenario tested in detail. At Blue Wealth we know that it’s your ability to hold an asset long term that’s the key to growth. Now more than ever, professional support is not only advisable but a necessity.

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